Leverage is one of the tools experienced traders use to increase trading profitability. You can apply it in various markets, such as crypto, stocks, forex, etc. Essentially, leverage enables you to trade at a bigger capacity with minimal resources, maximizing returns.
Are you planning to learn about leverage trading in crypto but aren’t sure how to sail through? We got you!
This guide takes you through everything you should know about the basics of leverage cryptocurrency trading, from what leverage trading is, how it works, to how to calculate leverage and mitigate risks of leverage crypto trading.
Let’s get started.
What is Leverage Trading in Crypto?
Leverage cryptocurrency trading is when you borrow assets from exchanges to amplify your trading capacity. In other words, you borrow to increase your buying and selling power in the market. This way, you end up operating with more capital than you actually have.
Moreover, there are various leverages based on the exchange you use. Some exchanges provide up to 20x your wallet deposit – if you have $500 in your wallet, you can trade for $50,000.
Usually, you describe leverage in ratios, like 1:2, which translates to a 2x leverage, 1:10, which translates to a 10x leverage, and so forth. As such, the ratio depicts the number of times the broker multiplies your wallet deposit. For example, if you deposit $200 in your wallet and open an ETH position with a 10x leverage, your $200 turns into $2,000.
($200 x 10 = $2,000)
Apart from using leverage to trade crypto, you can use it to trade cryptocurrency derivatives, futures contracts, etc. Nonetheless, you should be aware that leverage trading makes you highly vulnerable to risks that can cause huge losses. Now, how does leverage trading work?
You must deposit assets into your cryptocurrency trading account to open a leveraged trade. The deposit acts as collateral and varies based on the leverage you choose and the total amount of the position or margin you want to open.
For example, if you want to trade $500 in BTC with 2x leverage, you must deposit minimum collateral of $250 in your account. In this regard, you should always remember that the more leverage you use, the higher returns you will generate but the higher losses you will incur if the trade goes against you.
Other than the collateral, exchanges also require leverage traders to maintain margin edges for their trades. If the price of your leveraged asset doesn’t go as planned and its margin declines below the maintenance threshold, your broker will request you to add more assets into your account or undergo a forced liquidation, where your trading position will be closed due to inadequate funds.
Why Should You Use Leverage in Crypto?
Experienced crypto traders might consider using leverage if they want to build their trading position sizes and maximize profits. We will use another leverage trading crypto example to demonstrate this point.
Let’s assume you want to invest a minimum of $800, but you only have $400 in your account. You can execute your plan by using leverage as shown below:
$400 x 2 = $800. Thus, you can purchase $BNB worth $800 with just $400.
$400 x 5 = $2,000. Hence, you can buy $2,000 worth of $BNB using $400.
From the illustration above, it’s evident you can leverage to buy a significant amount of an asset with minimal capital in your trading account.
Now that you understand why experienced traders may want to use leverage in crypto, let’s briefly see how you can use leverage in crypto to master this topic better.
You can leverage trading crypto by going long or short. If you project an asset’s price will increase, you can take a long position/buy. But if you strongly feel the price will decrease, you can open a short position/sell.
As such, if you open a long position on ETH for $5,000 with a 2x leverage, you simply need to deposit collateral of $2,500. If ETH increases by 30%, you generate $1,500 as profit.
$2,500 x 2 (leverage) x 30% = $1,500
You will use a portion of the profit to pay interest rates and transaction charges. Eventually, you will realize the impact of leverage is larger than just using a capital of $2,500 to make a profit of $750. Remember, the reverse is also true.
Now, let’s see what happens when you create a short position with 2x leverage. Using $2,000 as collateral, a 2x leverage means you will have $5,000 in your account to sell. If Bitcoin depreciates by 30%, you can buy back (close the short position) the same amount of Bitcoin you borrowed with just $3,500.
$5,000 x (100% – 30%) = $3,500
Your profit: $5,000 – $3,500 = $1,500 (excluding minus interest rate and trading fees)
Here is a good analogy to understand shorting.
How Do You Manage Risks with Leveraged Trading?
While trading crypto futures can be highly rewarding because of the high leverage offered, the losses can be equally huge and sometimes bigger than the collateral. Therefore, it’s important to have a reliable risk management strategy. Below are three risk management strategies to apply in leverage cryptocurrency trading for maximum returns.
Establish Your Risk per Trade
Inexperienced traders often open big trade sizes, hoping to reap big. That’s awesome if your trade goes as planned, but you must consider what might happen if your trade doesn’t go as planned. As such, you should use a stop loss to cap your trading losses.
Assuming you are already using a stop loss, what percentage of your investment should you risk when your stop loss is hit?
© megha investments
From the statistics shown in the image above, it’s evident a minimal percentage loss requires an achievable percentage gain to regain your initial capital. For example, 5% and 10% percentage losses require almost similar percentage gains to recover (5.3% and 11.1% respectively).
On the other hand, high percentage losses require exponentially high percentage gains to regain your original capital. For instance, 90% and 95% percentage losses require percentage gains of 900% and 1900% to recover respectively. This means that it will be challenging to even recover your initial investment when your plan backfires.
In this regard, it’s advisable to only risk 2% of your trading amount per trade. In other words, after establishing your stop loss, you should set the amount of money you lose after your trade hits a stop loss to 2% of the trade. For instance, if you were leverage trading with $BNB worth $20,000, then 2% risk implies adjusting your trading size so that you lose $400 after hitting your stop loss.
Why is it 2% and not 15% or 25% risk per trade? Though 15% or 25% risk per trade is more profitable, you could easily blow up all your investment in less than five poor miscalculations. As such, the 2% risk per trade aims to leave you with substantial funds in your trading account even after incurring multiple consecutive losses.
Filtering Your Trades Using Risk/Reward Ratio
After determining your risk per trade, you should scan your trades using the risk/reward ratio. Remember, each trade you open entails exposing a portion of your investment to risk in exchange for potential profits.
You should establish your stop loss and take profit levels for every trade precisely through insights you get from your technical analysis and other trading strategies. These levels will enable you to find the rewards for each amount you risk per trade or the risk/reward ratio.
For instance, if you set your stop loss as $400 and the take profit as $2,000, then your risk/reward ratio is 5:1.
It would be best if you also determined your average win rate to maximize the risk/reward ratio. Generally, you can use the back-testing method to calculate your average win rate for every trading strategy. Moreover, you should only open trades with better risk/reward ratios based on your average win rate.
Determining Your Position Size
Now that you know your risk per trade and your risk/reward ratio, you can determine the amount of money you should invest per trade. Luckily, most exchanges offer trading tools for calculating profits/losses in leverage cryptocurrency trading.
After setting your entry and stop loss levels into the leverage calculator, change your investment amount (position size) so that the losses you incur after hitting the stop loss correlate with your risk per trade, recall point one, ‘Establish Your Risk per Trade’.
Besides, you should factor in the liquidation point. Consider modifying your trade parameters if your position hits a liquidation point before a stop loss.
What is Margin Trading?
We can liken margin trading to buying on credit. In other words, you borrow assets from a broker to use them to make trades. The act of using margin to trade is referred to as leveraging since it entails borrowing funds to maximize profits.
Margin capital is a loan bearing an interest rate and collateral, which your exchange sets. Moreover, your account level and the amount you borrow significantly affect your interest rate. In margin trading, you should also retain a margin balance, commonly known as a maintenance margin, in your account to take care of losses. Additionally, you must deposit some funds to act as security for the assets you borrow. These deposits are known as collateral.
On the other hand, funding rates refer to intermittent payouts made to investors based on perpetual contract markets and spot prices. A perpetual contract enables you to trade an asset at a future date for a specified price at a marketplace known as a perpetual contract market. Both perpetual contract and spot markets inhibit lasting divergence in the prices of assets.
Lastly, liquidation is the forced closing of a trader’s position because of the fractional or complete loss of the initial margin. This often occurs when traders lack adequate capital to maintain their positions.
Here is the formula for calculating leverage in crypto:
Leverage = 1/(Margin) = 100/(Margin percentage)
Assuming the margin is 0.04, then the margin percentage is 4%
Leverage is 1/0.04 = 25
To find the margin used, multiply your trade size by the margin percentage.
Platforms for Leverage Crypto Trading
These are some of the best exchanges for leverage cryptocurrency trading:
Binance is the leading crypto exchange in transaction volume. Initially, Binance only supported spot trading, but in 2019, they started supporting leverage crypto trading. You must pass the Know Your Customer (KYC) identification process and be a non-US citizen to qualify for Binance’s leverage trading.
Depending on your coin pairing, Binance leverages differ and can be up to 20x. Interest rates also vary based on your margin account level and the type of asset you borrow. When you pay your interest rates using $BNB, you’ll receive a 5% discount.
Apart from that, Binance has put up a Margin Insurance Fund to secure its liquidity. If you go bankrupt during leverage trading and your funds are insufficient to clear your debts, then the platform clears your debt using the insurance fund.
Though FTX is relatively new, it’s a dynamic leverage cryptocurrency trading platform providing various derivatives. It was launched in 2019 by Alameda Research founders, and it has emerged as one of the top exchanges for spot and leverage trading with minimal trading fees.
FTX supports more than 150 perpetual and quarterly futures, leveraged tokens, and Bitcoin options to help crypto investors trade and explore diverse market opportunities. Its user-friendly interface allows even first-time users to enjoy leverages of up to 20x.
You can also access leverage options for minimal collateral and apply stop-loss to avoid hitting the liquidation point. Besides, FTX’s trading tools are the best as they support leveraged tokens with low-cost trading fees for any position you want. They charge 0.02% as maker fees and 0.07% as taker fees, but you can cut these charges by almost 60% using FTX’s native token – $FTT.
In addition, FTX has multiple order types for trading and a seamless trading engine to prevent imbalanced liquidations and supportive customer care. Unlike Binance, FTX doesn’t require you to pass the KYC process to start leverage trading crypto.
Kraken is a US-registered crypto exchange and allows US crypto traders to participate in leverage trading. It has been in operation since 2014, and it’s among the biggest exchanges by daily transaction volume.
Because of the stringent US laws, Kraken offers up to 5x leverage. While this leverage looks dismal compared to Binance and FTX, it’s ideal for now and will likely improve as the US adopts a clearer crypto regulatory framework.
You can open long and short leverage trading positions for Bitcoin, Bitcoin Cash, Ripple, Ethereum, and more on Kraken. The exchange is proactive in providing better customer support to its users; therefore, they will guide you accordingly on how to move along.
Leverage cryptocurrency trading improves your buying and selling capacity by allowing you to operate with more capital than what you have. Nonetheless, the crypto market is highly volatile, and high leverage can cause liquidation risks. Therefore, always trade with caution and conduct a thorough technical analysis of an asset before leveraging it. Above all, never risk more than you can afford to lose.
Crypto beginners are advised to keep off leverage trading as it’s a highly risky investment strategy. Otherwise, professional traders can use leverage to maximize trading profits if they properly manage it.
What is 20x leverage?
A 20x leverage means your broker will multiply your account deposit by 20 when trading on leverage. For example, if you deposit $500 in your wallet and open a BTC position with a 20x leverage, your $500 turns into $10,000.
What is a leverage trading crypto example?
Leverage trading crypto is when you borrow assets from a broker to amplify your trading position. Below is a leverage trading crypto example:
Let’s assume you want to purchase ETH worth $2,500, but you only own $250 in your account. In this case, you can still achieve your dreams by using a leverage of 10x. If your trading plan goes as projected and you make a profit of $1,500, you will return the borrowed funds and interest to your broker and keep the balance.
How long do leverage positions remain open?
The maximum period most exchanges will allow you to maintain your leverage positions is one year. You should monitor your open positions throughout this time to ensure you don’t miss your token’s peak price for maximum profits.
Josiah is a tech evangelist passionate about helping the world understand Blockchain, Crypto, NFT, DeFi, Tokenization, Fintech, and Web3 concepts. His hobbies are listening to music and playing football.
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